Published online by Cambridge University Press: 07 October 2011
The past decade witnessed a substantial reevaluation by economists of previously established views concerning inflation and its interaction with real phenomena. In particular the stable inflation–output trade-off view popularized during the sixties was strongly shaken both by new theoretical developments and by the stagflation of the mid-seventies. The behavior of inflationary expectations was recognized as a prime determinant of the real effects of inflation. New evidence and theory suggested that the distribution of relative prices is not independent of the distribution of inflation in direct contradiction to the neutrality of money paradigm. Simultaneously the idea that expectations are formed rationally with all the available relevent information being used became a major element of macroeconomic thinking and modeling.
Those changes, which were spawned by the relative failure of Keynesian policy prescriptions during the seventies, reopened the age-old question regarding money, inflation, and their interaction with real phenomena. Two families of theories, both grounded in rational expectations, were developed during the seventies to explain those interactions. One following the Keynesian tradition relies on price rigidities created by implicit or explicit contracts. The other is based on imperfect information.
This book is a summary of the imperfect information approach to macroeconomic modeling. Two types of informational limitations are considered. One involves models in which individuals have asymmetric information about the current general price level and consequently suffer from the aggregate–relative confusion.